If you own a business, chances are pretty good that you will enter into a commercial lease at some time during the life of your company. While each lease is different and must be reviewed carefully, commercial leases typically cover a core group of issues and if you are considering leasing commercial property it’s important have a basic understanding of these terms. The following is a partial list and brief explanations of some of the most essential terms and topics addressed in a commercial lease.
A commercial lease should clearly define the space that the tenant will be leasing, also known as the “premises” or “demised premises.” Leases typically include both a street address and a floor, or site, plan showing the premises and its dimensions in square feet (SF). Make sure the lease clearly defines the premises, and that the description in the lease matches the space you are expecting to receive. Also, verify that your commercial space has sufficient parking and signage rights to allow you to maximize your business operations.
A commercial lease should tell you what is included in the rental amount that you will pay to the landlord. Most lease types are either “gross” or “triple net”, but they can also fall somewhere in the middle. Unfortunately, not all leases will state explicitly into which category they fall, so it is imperative that you carefully read the entire lease before signing it. Understanding the difference between a gross and triple net lease is particularly important when comparing multiple properties because it helps to ensure that you are comparing “apples to apples.” Below are brief definitions of the core types of leases.
o Typically all-inclusive – tenant pays the landlord one monthly lump sum.
o Landlord is responsible for payment of real estate taxes, insurance and maintenance expenses.
o Tenant utilities may or may not be included in the rent within a gross lease.
o Tenant pays a base rental amount to the landlord, but also pays a share of the landlord’s real estate taxes, insurance, maintenance expenses, and building utilities.
o Tenant is responsible for all expenses for utilities (power, water, data, etc.) servicing their space.
A commercial lease should clearly define what your rental rate will be for the entire term of the lease. Generally, this is done through a rental chart which states the annual rental rate for each year of the lease and what the tenant’s equal monthly payments will be based on the corresponding annual rate. In most leases, the annual rental rate increases from year to year either by a flat amount (say, 3.0%) or by reference to an exterior formula (say, in proportion to increases in the cost of living allowance (Consumer Price Index)). In some retail leases, the tenant is responsible for paying the annual rental amount plus a percentage of the tenant’s sales for the year, which is known as percentage rent.
A triple net commercial lease should state the amount, if any, the tenant must contribute toward “common area maintenance” expenses, or CAM. Often, CAM includes costs of snow removal, security, parking attendants, building maintenance, building management fees, etc. The simplest method for determining a tenant’s share of CAM is to divide the number of square feet in the tenant’s space by the total number of rentable square feet in the office building or shopping center. Of course, commercial leases do not always handle things in the simplest manner, so CAM allocation should be reviewed carefully.
A commercial lease likely will tell you what you can and cannot do in your demised premises. Office leases often state that the space will be used for general office use and for no other purpose. Retail spaces often get more specific. Further, you need to know whether your lease includes an “exclusive,” which is a provision that gives you the exclusive right to operate your type of business in the building or shopping center. Exclusives are the reason that you rarely see competing pizza places in the same shopping center.
A commercial lease should clearly define who is responsible for repairs of the demised premises, the building, the parking lot and the core building systems (plumbing, electric, HVAC, etc.). Keep in mind that the question here is not who pays for the repairs, but who is responsible for making sure the repairs are made in the first place. Commercial tenants often maintain the demised premises and any core building systems to the extent they are located within the demised premises, while the landlord maintains everything else.
Commercial space tends to be rather generic and may require modifications, or a “build-out”, for use by a particular tenant. Accordingly, a commercial lease often states whether the landlord or the tenant will make improvements to the demised premises to get ready for the tenant’s occupancy. When the landlord pays for the improvements, the amount spent by the landlord is called an “allowance.” If improvements are contemplated, the lease must clearly state what improvements will be made, who will complete the improvements, when the improvements will be complete, and the amount of any allowance.